When traders open a chart for the first time, they will likely see a few indicators. Yet, as traders start learning more, they believe that more indicators will help in the process.
Eventually, they wake up one day realizing their charts are a cluttered mess, not helping but negatively impacting their performance. These traders often decide to start anew, using a clean chart and looking exclusively at prices.
This article will examine price action trading — why less is more and how to identify and profit from the most popular price action strategies.
What is Price Action Trading?
Price action trading is often a day trading method where traders make decisions based strictly on price movement, not indicators.
For that reason, price action trading is often referred to as naked chart trading, as the charts contain few, if any, objects — usually just candlesticks that map the price movement giving four pieces of key information: open, close, high and low.
Like most strategies, price action trading looks for repeatable patterns that reoccur on the market, usually using candlestick patterns as triggers and concepts like support or resistance for refining the entry and exit plan. Although trading a naked chart might seem straightforward, it takes some practice to objectively assess the market conditions and avoid ambiguity. Therefore, price action trading is often not the best for beginner traders.
This strategy is prevalent for intra-day trading, but its essence is fractal — meaning it works on any timeframe.
Why Do Forex Traders Use Price Action?
Forex charts are often cluttered with obscure indicators that might even give contradictory signals. Because all indicators derive from price movement, trading price action attempts to cut through the noise and observe all the information directly at the source.
Traders who use price action look at the price chart as the origin and the end of all the trade decisions, looking to stack the odds in their favor by engaging in high-probability setups.
Price Action Trading Strategies
Price action trading strategies revolve around repeatable patterns that occur on the market. Here are some of the most popular price action patterns and tips on identifying and trading them.
1. Order Block Retest
The order block concept has been around for a long time, with more than one interpretation. In the late 2010s, a group of British traders started using it to reference the last bullish candle in a swing high or the last bearish candle in a swing low.
By dividing this candlestick in two, the price action trader gets a very concise point of support and resistance to framing a trade. Essentially, trading an order block is looking for the price to retest this level and then failing to break it. It is a reversal pattern that creates a favorable risk-to-reward ratio, usually 1:2 or better. The stop-loss level should be below the swing point or 10% of the average true range (ATR).
2. Head and Shoulders Reversal
By far the most popular trading pattern, head and shoulders is also one of the most-studied price action patterns in history.
It is a relatively simple pattern characterized by four elements: the left shoulder, peak, right shoulder and neckline. Traders usually start noticing the pattern once the peak forms and then wait for the shoulder formation and a neckline break.
Like with many candlestick patterns, the profit measure equals the width of the formation. In this case, that is the distance between the neckline and the peak.
3. Average True Range Exhaustion
Average true range (ATR) is one of the few must-have indicators. It shows the average movement for the particular currency pairs over a certain period of time. It gives clear levels where the strong trending move could start losing its steam.
It is an intra-day reversal strategy that works best when paired with reversal candlestick patterns.
4. Inside Candle Formation
Also known as harami, it is a two-candlestick pattern representing indecision in the market and a possible reversal.
Its name comes from the fact that the second candle forms and closes within the previous candle’s range. A bullish harami appears in decline, while a bearish harami appears after an upward move. Traders usually look for critical support and resistance points and use this pattern to predict reversals.
5. Hammer and Shooting Star
The hammer is a popular price action pattern signaling a potential move upward. It is a single candlestick with a lower wick that is much longer than a rather small candle body.
Essentially, it represents a steep price decline met with strong buying action that ends with a higher close.
The shooting star pattern is the exact opposite. It is a candlestick with a long upper wick and a small lower body that ideally closes below the open.
Open a Trading Account and Master Market Movement as a Price Action Trader
Few traders start trading price action early in their careers. For most of them, it is a journey through different strategies to find out what suits them the best.
Some end up swearing by price action, having excellent results and arguing that less is more. Still, this doesn’t mean these strategies suit everyone, especially beginners. Price action strategies require a refined eye and a level of market intuition gained only after spending hundreds of hours observing the price movement.
Frequently Asked Questions
Does price action really work in forex?
When understood well, price action is one of the best approaches to trading the foreign exchange (forex) market. Price action is all about finding and interpreting clues about where the market is likely going next before it happens. Usually, it works by finding high-probability patterns and following a strict risk-management plan.
Is trading price action profitable?
Understanding price action is as close to a “Holy Grail” as forex gets. All information is already imbued within the price movement so every indicator is simply a derivate that helps understand it. In a way, price action is like a machine language, while the indicators are programming languages — simplified versions of the same message.
What is the best indicator for price action?
Price action trading, by its definition, avoids relying on indicators as execution triggers. Still, some indicators help in trade planning. The average true range (ATR) is one of the best, showing the average expected price movement for that day. Using this information, traders can formulate a better exit strategy, especially if trading intra-day.